SII: COMMODITIES – THE EV REVOLUTION – LITHIUM INVESTING

SII: COMMODITIES - THE EV REVOLUTION - LITHIUM INVESTING

The EV Revolution? - The trouble with Lithium investing

The rise of electric vehicles has been nothing short of spectacular. Just a decade ago, few could have imagined the level of interest from major manufacturers in producing EVs. Much of the credit goes to Tesla – their disruptive attempt to bring EVs to the mass market has spawned a boom in new models under development by established players.

The sky is the limit for the proliferation of EVs; but back on Earth, how can investors get involved?

Lithium

Everybody knows the story on lithium, it seems. This is the go-to mineral for people looking to ride on the coattails of the EV revolution.

Lithium is not especially rare, but neither is it very common – at least in terms of economically appealing extraction methods. Lithium, along with other elements, is used in most current battery cells:

Source: Visual Capitalist

Lithium prices have risen dramatically since 2015, from ~$6k/tonne to ~$16k/tonne, as a result of increased demand. The LME is now looking at establishing lithium contractsto tap into this previously sedate market.

So how are investors getting in on this hot trend?

Well for one thing, you can buy the Lithium ETF from Global X Funds – and investors have certainly been doing that: Funds under management have practically doubled in six months as investors have plowed $240m into the fund:

Source: ETFdb.com

So what do you get in the Global XLithium ETF, then?

Lots of lithium mining companies and price exposure? Well, not exactly – here are the top 10 holdings:

Source: ETFdb.com

Curiously, Samsung, Panasonic, LG Chem, GS Yuasa, Simplo, and Enersys are generally consumers of lithium as battery producers – they are companies that stand to benefit from declining lithium prices! Tesla, too, is an end user of lithium via purchases of batteries, as is BYD, a Chinese automaker…

Still, the stated aim of the fund, it seems, is to take both sides of the trade in lithium:

The Global X Lithium & Battery Tech ETF (LIT) invests in the full lithium cycle, from mining and refining the metal, through battery production.

What about those two mining companies that make up 42% of the fund?

FMC Corp

This company is a large agricultural chemical producer and a major producer of lithium. The company forms one quarter of the entire $0.5bn ETF. What proportion of its revenues comes from lithium (blue wedge)?

Source: FMC Corp Presentation

Understandably, FMC are rapidly expanding lithium production, following the money. Lithium used to be a sideline business for agricultural chemical producers like FMC and SQM – now it’s a core growth area.

FMC are expanding in South America, where lithium can be produced most cheaply. This is because vast salt flats in Chile, Argentina, and Bolivia allow very cheap extraction – you pump lithium-rich brine water to the surface; the sun evaporates the water – you collect and process the lithium. This is a very low-energy, low-cost production method with a light carbon footprint.

Source: Reuters

SQM

SQM is arguably the world’s lowest-cost producer of lithium and 17% of the Global X fund – is it the best way to gain lithium exposure? Well, not entirely, although the company does have a high leverage to the price of lithium:

Lithium is around 1/3 of revenues but 2/3 of profits due to both the exceptionally high market price of Lithium and SQM’s exceptionally low cost of production. But, as ever, exceptional profits tend to attract both competition and regulatory interest. Investors who have done their homework will have noted the following dispute with the Chilean government, currently in arbitration:

If the arbitration decision revokes SQM’s concession to operate in the Salar de Atacama it will severely affect the company’s operations, as 48% of revenues come from products derived from the Salar.According to SQM, it has assets located in that region worth around USD1 billion, which could be sold under such scenario. While this strategy would support the company’s liquidity, it would not offset the sharp cutback in top line and profitability. Under a different scenario, the result of the arbitration could be the continuation of the concession with a potential payment by SQM of an economic penalty to CORFO, which is the most likely possibility in our analysis. However, given the nature of the arbitration procedure we view the final result as uncertain, including a potential high-impact outcome.

Therefore, the most lithium-exposed investment in the whole ETF could potentially lose its entire lithium operation. Even if SQM doesn’t lose the concession, it stands to reason that the Chilean government will change the royalties regime to create a windfall tax on lithium and open more of the salt flats to competitors.

This development still hasn’t put off thematic investors: SQM shares are up 87% YTD, with the Lithium ETF up 49%!

Passive investing = lazy investing

Buy an S&P 500 ETF and you get diversification. The index consistently changes to include promising new entrants, and declining businesses are slowly but surely booted out before they kick the dust. However, the passive investing boom is creating all manner of custom thematic baskets that have very little exposure, or very skewed exposure, to the expected theme.

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